This One’s on the House

This week, Kevin McCarthy became the first person in 134 years to be ousted as Speaker of the United States’ House of Representatives. McCarthy forged a deal with the Democrats to avert a government shutdown (until November 17, at least) and the Freedom Caucus of his own party sealed his fate.

After watching McCarthy win the speakership over four long days and fifteen ballots last January, are you surprised?

We didn’t need more convincing, but this is the latest confirmation that Washington is dysfunctional. However, it comes at a time when interest rates are rising – fast and by a lot.

The 10-year U.S. Treasury yield was 3.7% when McCarthy won his speakership in January. Today, it’s a full 100 basis points higher at 4.7%. In other words, the cost to finance government debt is getting more and more expensive.

The federal government runs a deficit each year that’s almost $1.8 trillion. Almost 40% of that is just the interest on the debt, which currently costs $713 billion per annum. By comparison, the federal government spends $795 billion on defence, $1.3 trillion on social security, and $1.6 trillion on Medicaid and Medicare.

In case you were wondering the size of the U.S.’s total national debt, it’s about $33.4 trillion.

There will be a consequence to political dysfunction, a higher cost to borrow, and a ballooning debt situation. Much like the condition faced by Canada’s finance minister, Paul Martin, in the mid-1990s, once the interest payments grew out of control, austerity became inevitable.

Though the debt situation is alarming, and austerity would lead to a recession, we’re not concerned about the potential for a government shutdown on November 17. Historically, government shutdowns have had only minimal stock market impacts. In fact, the S&P 500 has gained 4.4% during such events.

We believe the next Federal Reserve Chair will be more politicized than now and that person will be pushed to keep rates (and interest costs) low to avoid the political suicide that would accompany austerity. However, Chair Jay Powell’s term doesn’t conclude until January 2028.

Until then, spending slowdowns will be a compromise as interest costs soar and the debt situation worsens. This will reduce inflation, give its central bank leeway to reduce rates, and consequently the price of stocks will appreciate.